In an article in The Regional Economist, Vice President and Economist Stephen Williamson wrote: “Neo-Fisherism says … that if the central bank wants inflation to go up, it should increase its nominal interest rate target, rather than decrease it, as conventional central banking wisdom would dictate. If the central bank wants inflation to go down, then it should decrease the nominal interest rate target.”

The Fisher Effect

Williamson discussed a key component of essentially all macroeconomic models: A positive relationship exists between the nominal interest rate targeted by a central bank and inflation. This so-called Fisher effect is named for the early 20th century American economist Irving Fisher.

While this relationship is typically interpreted as involving causation running from inflation to the nominal interest rate, Williamson wrote, “what if we turn this idea on its head, and we think of the causation running from the nominal interest rate targeted by the central bank to inflation? This, basically, is what Neo-Fisherism is all about.”

The Taylor Principle

Williamson posed the question of what could go wrong if central bankers do not recognize the importance of the Fisher effect in formulating monetary policy and they instead conform to conventional central banking wisdom.

He noted that conventional wisdom is embodied in the Taylor rule, which was proposed by economist John Taylor.1 “Taylor appears to have thought, in line with conventional central banking wisdom, that increasing the nominal interest rate will make the inflation rate go down, not up,” Williamson said. In particular, the so-called Taylor principle calls for the nominal interest rate to increase more than one-for-one with an increase in the inflation rate.

Consequently, if the inflationary process works as described above but a central bank follows the Taylor principle, Williamson said that macroeconomic theory predicts the central banker would almost inevitably arrive at the zero lower bound on nominal interest rates.

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